Introduction
The term “Note of Historical Cost Profits and Losses” refers to a memorandum item in the annual accounts and report of a company. It provides an abbreviated restatement of the profit and loss account, showcasing the reported profit or loss as if no revaluations had been made.
Historical Context
In the UK, the Financial Reporting Standard (FRS) 3, titled “Reporting Financial Performance,” mandated that companies include a note of historical cost profits and losses in their financial reports. This requirement aimed to provide clarity by presenting financial performance without the adjustments from asset revaluations.
Key Events
- Introduction of FRS 3 (1990s): FRS 3 introduced the requirement for the note of historical cost profits and losses.
- Debate and Criticism (2000s): The accounting community expressed concerns about the usefulness and relevance of this note.
- FRS 102 (2015): The new Financial Reporting Standard Applicable in the UK and Republic of Ireland (FRS 102) omitted the requirement for this note.
Detailed Explanations
Importance and Applicability
The note was designed to assist stakeholders in understanding the underlying financial performance of a company without the distortions caused by asset revaluations. While it aimed to provide transparency, many accountants questioned its practical value, especially as financial reporting standards evolved.
Financial Reporting Models
The primary financial statements involved in this note are:
- Profit and Loss Account: Shows the company’s revenues and expenses, culminating in the net profit or loss.
- Historical Cost: Refers to the original purchase price or cost of an asset, without considering subsequent revaluations.
Charts and Diagrams
graph LR
A[Annual Financial Report]
A --> B[Profit and Loss Account]
A --> C[Balance Sheet]
B --> D[Note of Historical Cost Profits and Losses]
D --> E[Reported Profit/Loss]
D --> F[Adjustment for Revaluations]
E --> G[Historical Cost Profit/Loss]
Examples
Company X:
- Reported Profit/Loss with Revaluations: £1,200,000
- Adjustments for Revaluations: +£300,000
- Historical Cost Profit/Loss: £1,500,000
Considerations
Pros:
- Transparency: Provides a clearer picture of the company’s profitability.
- Consistency: Useful for comparisons across companies that may not follow the same revaluation policies.
Cons:
- Questionable Value: Many professionals viewed the note as unnecessary due to other comprehensive income statements.
- Redundancy: Modern standards provide detailed disclosures that often make such a note redundant.
Related Terms
- Historical Cost Accounting: An accounting method in which assets and liabilities are recorded at their original purchase costs.
- Fair Value Accounting: An alternative method where assets and liabilities are recorded at their current market value.
Comparisons
Historical Cost Profits and Losses vs Fair Value Profits and Losses:
- Historical cost presents a static view, often lower, while fair value reflects current market conditions, potentially showing higher or more volatile profits/losses.
Interesting Facts
- The historical cost principle is still widely used in GAAP (Generally Accepted Accounting Principles), especially in the United States.
- Some accounting standards, like IFRS (International Financial Reporting Standards), allow for more frequent revaluations compared to GAAP.
Inspirational Stories
While there aren’t specific stories directly linked to the note of historical cost profits and losses, the debate surrounding its usefulness showcases the dynamic nature of financial reporting and the importance of evolving standards to meet stakeholders’ needs.
Famous Quotes
- “Accounting does not make corporate earnings or balance sheets more volatile. Accounting just increases the transparency of volatility in earnings.” - Diane Garnick
Proverbs and Clichés
- “Numbers never lie, but they can be made to tell different stories.”
Expressions, Jargon, and Slang
- Straight-Line Accounting: A method that avoids adjustments like revaluations, similar to historical cost principles.
- Write-Up: An increase in the book value of an asset due to its revaluation.
FAQs
Q: Why was the note of historical cost profits and losses removed in FRS 102? A: The note was removed because many accountants found it redundant and less useful compared to other comprehensive disclosures in the modern financial reporting frameworks.
Q: Are companies still required to report historical cost profits and losses? A: No, under FRS 102, this specific requirement has been eliminated, though similar disclosures might still exist in other reporting standards.
References
- Financial Reporting Standard (FRS) 3
- Financial Reporting Standard (FRS) 102
- ICAEW: The Institute of Chartered Accountants in England and Wales
Summary
The Note of Historical Cost Profits and Losses was a financial reporting requirement aimed at providing transparency by excluding revaluation effects. While well-intentioned, it faced criticism and was ultimately removed in newer standards like FRS 102. Understanding its historical context and purpose provides valuable insight into the evolution of financial reporting standards and practices.
